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03 11 2016 | by Victor Xing | Central Banks

FED communication and market recap ahead of March FOMC

Federal Reserve communication preceded the March FOMC blackout period were mostly dovish despite strong domestic data.  Nevertheless, three sources of policy concerns – economic conditions in China, dollar valuation and prices of oil, have largely stabilized in recent weeks.  As a result, risks of a less dovish than expected surprise at the March FOMC had risen (and partly priced into the market), and both Vice Chair Fischer and Governor Brainard had dropped less dovish hints in their pre-blackout speeches.

A few hawkish hints amongst dovish FED communication

Vice Chair Fischer’s March 7th speech highlighted optimism on inflation and positive effects of low oil prices

  • The Phillips curves are not broken – “we may well at present be seeing the first stirrings of an increase in the inflation rate – something that we would like to happen”
  • Overall effect of the decline in oil prices will be a positive driver in aggregate demand in the U.S., even though the decline in price of oil had negatively affected investment in equipment and structure needed for shale oil production, which had “become an important component of aggregate U.S. investment”
  • Jury is still out on secular stagnation – “At present, it looks likely that the equilibrium interest rate will remain low for the policy-relevant future, but there have in the past been both long swings and short-term changes in what can be thought of as equilibrium real rates”

In her March 7th speech, Governor Brainard acknowledged that financial conditions “have improved in recent weeks” after “tightened somewhat” in recent months.  Nevertheless, much of her speech remain focused on the persistently low inflation and softer inflation expectations (University of Michigan Surveys of Consumers, New York Fed Survey of Consumer Expectations, as well as TIPS breakevens, albeit partly due to energy prices and risk premium).  Once again, Governor Brainard argued that “tighter financial conditions and softer inflation expectations may pose risks to the downside,” and “patience” is warranted from a risk-management perspective.

Dollar, yuan, and oil

Recent stabilization in dollar valuation, yuan exchange rate, as well as prices of crude oil should ease some concerns on the inflation front.

March FOMC Preview
Federal Reserve’s Trade Weighted Broad Dollar Index has declined to 4Q 2015 levels
March FOMC Preview
Renminbi effective exchange rate remains relatively stable
March FOMC Preview
Oil prices have rebounded from February low

Market expectations

Investors had largely priced out probabilities of any rate hikes in 2016 during the height of February’s oil rout, but higher oil prices, strong payrolls and firming inflation data have again forced front-end longs to capitulate.  Currently market participants are pricing in 1.36 hikes for the year according to Jan 2017 Fed funds futures:

March FOMC
Fed funds futures have pared February gains as oil prices and yuan exchange rate stabilize





Next article03 04 2016 | by Victor Xing | Economics

February payrolls: a deep dive into the employment report